Trade Costs and Trade Patterns

A notable feature of developing Asia's intraregional trade is the growing volume of shipments of parts and components across national borders. Fragmentation of production supply chains and sourcing raw and intermediate inputs from wherever costs (including related trade costs) are lowest has yielded benefits for both producers and consumers, as well as tax revenues for government budgets. At the same time, the double (or triple) shipping it involves puts greater strain on existing trade-related infrastructure and raises the demand for timely delivery and greater information on shipping status enroute. To compete for larger shares in these benefits, countries have been striving to lower their costs by increasing the quantity and quality of services to support the production, distribution, and international trade of a widening array of intermediate goods and services.

As infrastructure expanded in Asia, particularly in East Asia, trade costs fell and altered the comparative advantages of countries in the region, making greater fragmentation of production supply chains possible and spurring the region's intraregional trade in intermediate products. The subsequent economic integration in East Asia is sharply higher than in other developing regions (Figure 3 [ PDF 16.4KB | 1 page ]). When inputs are being sourced from wherever costs are lowest and the production process increasingly dispersed geographically, then timeliness and reliability of delivery become critical factors and the influence of both physical and institutional infrastructure services at the regional level is even more apparent. In this context of production fragmentation, East Asia's performance in reducing border trade costs stands out again relative to other developing regions (Table 1 [ PDF 15.2KB | 1 page ]).

Infrastructure influences not only absolute, but comparative, advantage. Differences between countries in the quality of infrastructure services help to explain differences in total factor productivity. These impacts on productivity vary across sectors, depending on how intensively each sector uses infrastructure services and how reliant it is on the quality of infrastructure services (and the availability of technology for alternative production processes). Thus, patterns of specialization and trade are determined in part by the influence of infrastructure service quantity and quality on comparative advantage. Hummels and Skiba (2004) estimate that a 10% increase in product price leads to an 8.6% fall in the ad-valorem transport cost. Thus, transportation costs alter the relative prices of different quality goods, indirectly changing the composition of trade.

Limitations in factor endowments may be mitigated by infrastructure services, also affecting the dynamics of comparative advantage. In different production processes, infrastructure services may serve either as complements to, or substitutes for, physical inputs. The significance of factor endowments in determining comparative advantage may thus be modified by infrastructure development (Brooks and Leuterio 1997; Yeaple and Golub 2002).

Hummels (forthcoming 2009) looks at four types of recent changes in the composition of trade and their effects on demand for transportation: (1) changes in the ratio of weight to value of traded goods, (2) demand for timeliness and the shift towards increased air shipping, (3) new trade flows (both of products and geographical routes) and variation in the size of shipments, and (4) production fragmentation. The relationships are complex since the developments are interlinked. For example, declining weight/value ratios and vertical specialization in the fragmentation of new production supply chains generate new trade flows and patterns which have spurred the rapid growth in Asian air cargo shipments.

When infrastructure development lowers the marginal cost of trade, there can be increases in exports at both the extensive and intensive margins. The expansion at the extensive margin (of new products, to new destinations), typically through small shipments from small firms, influences the types of infrastructure services demanded differently than does the deepening of existing trade flows. This is especially true for transportation infrastructure demand. When the new markets are inland, air transport may be a viable alternative to a combination of sea and land freight to avoid and reduce potential port congestion, noting that the shipping time savings are positively correlated with the shipping distances involved.

The surge in oil prices during 2008 raised shipping (and therefore import) costs, shifting the balance in favor of domestic producers and inflation. Changes such as this can have a double or greater impact on products in international supply chains as both imported inputs and exported final products register higher prices. For example, Chinese steel produced with iron ore imported from Brazil and exported to the US was hit twice by higher fuel charges. The impact is obviously greater where the goods (or their imported components) are shipped by air or have a high weight-to-value ratio and therefore where fuel accounts for a higher share of freight costs. The demand for modal switching places a premium on interoperability, an area where smoother regional connections and harmonization of standards can make a large difference in competitiveness.

Malaysia is a prime example of a country where the government has actively promoted infrastructure development in order to strengthen its competitive and comparative advantage. Since the mid-1980s, Malaysia has pursued an FDI-led, export-oriented development strategy, with FDI contributing to the economy's integration into global production networks. As Tham, Devadason, and Heng (forthcoming 2009) point out, foreign firms' interest in Malaysia as a key link in global and regional supply chains has been piqued by the country's competitive locational advantages, which in turn are closely linked to its infrastructure development and resulting high quality services.

Tham et al. illuminate the role of infrastructure in attracting export-oriented FDI through observing FDI's sectoral and locational pattern and through interviews with managers of local subsidiaries of foreign firms involved in international trade. The location of FDI is found to be biased toward areas with relatively good infrastructure and amenities, as could be expected. Thus, infrastructure improvements increase the chances of attracting foreign direct investment, which in Malaysia as well as other areas in Asia has frequently been directed toward export sectors, and therefore also influence patterns and quantities of imported raw materials and intermediate inputs.

Amiti and Javorcik (2006) find that market and supplier access are the most important factors affecting foreign investors' entry into an economy, and have about four times as great an effect on the choice of foreign investment location as do production costs. In particular they find that in PRC, access to markets and suppliers within the province of entry matters more than access to those in the rest of the country, consistent with observed market fragmentation. An increase in trade-related infrastructure of one standard deviation in the number of sea berths is found to result in an increase of foreign entry by about 11%, while a one standard deviation increase in the length of rail lines increases it by 7%. This supports the observation that provinces with more developed ports, and to a lesser extent a more developed rail network, tend to attract greater FDI inflows. Over time, however, related factors such as congestion, security concerns, connectivity of airports, and delays in processing trade documentation may reduce the positive impact of infrastructure on lowering trade costs for foreign investors.

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